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Who is getting robbed? The REAL “intergenerational theft”

Marshall Auerback here with a post which I originally published at New Deal 2.0.

What is a fiscal crisis? When does deficit spending become “unsustainable”? Today, we can see net public spending rising (sharply as a percentage of GDP in some cases) as private spending has plummeted. Still, unemployment has skyrocketed. So whatever government spending has hitherto taken place has been insufficient to offset the loss of private sector output.

Here is the true nature of  today’s “crisis”: Governments are unwilling to net spend at a sufficient scale to stop the increase in unemployment. That unwillingness reflects a political constraint — which is now being dressed up by some as a matter of national security or a symptomatic of “political gridlock,” as the NY Times seeks to argue (”Party Gridlock in Washington Feeds Fear of a Debt Crisis“).

Exhibit A: According to the NY Times, it is “the unwillingness of the two parties to compromise to control a national debt that is rising to dangerous heights.”  Given the state of the economy, maybe we should be thankful for political gridlock, especially if it has prevented deficit terrorists like soon-to-retire Senator Evan Bayh from implementing some of his crazier ideas about cutting back government spending.

We’re always told that our debt levels have risen to “dangerous heights”, but we seem to mix up the causation. Budget deficits go up as growth slows due to the automatic countercyclical stabilizers; they don’t cause the slowdown, but merely represent it. What Senator Bayh and others of his ilk fail to understand is that while you can cut spending, and raise taxes, you cannot eliminate deficits via legislative fiat in the absence of dis-saving from some other non-government sector.

My main critique of the deficit hawks is that they (and policy makers and investors who embrace their philosophy) simplistically focus on changing one sector’s financial balance without taking into consideration the implications for other sectors. If sharp reversals of fiscal deficits are attempted, the domestic private sector’s ability to service debt will be impaired unless large current account surpluses can be achieved. That means domestic wage deflation (which will get their private sectors to financial instability straight away) or a magnificent explosion of labor productivity and product innovation, the likes of which we have no reason to expect will spontaneously arise in the near future.

Even though the US doesn’t operate under the same kinds of explicit constraints as the European Monetary Union (EMU), a fundamental misunderstanding of how our actual modern monetary system works is driving us to the same stupid conclusions and outcomes as the EU.

Here’s a better demonstration of what we are talking about, courtesy of Professor Bill Mitchell from the University of Newcastle

It’s worth reading this piece in its entirety, but the main point we want to highlight is Mitchell’s analysis of data from the US Office of Management and Budget. He points out that in the summary for receipts and outlays from 1930 to today (along with projections to 2015), “the US government’s budget was generally in deficit of varying proportions of GDP 67 of those years (that is, 84 per cent of the time).” Mitchell also notes (as both Randy Wray and I have discussed several times before ) that each time the government has tried to push its budget into surplus, a major recession followed which forced the budget via the automatic stabilizers back into deficit.

These deficits have provided support for private domestic saving over most of this period. In times of significant national crisis — the Great Depression and World War II — budget deficits as a percentage of GDP rose as high as 30%.

Now, if budget deficits were truly as injurious to national security as the many of the deficit hawks now allege, why on earth would a country want to run them during wartime, when presumably the threat to our national security is at its greatest? Taking this logic to its perverse extreme, why would one ever declare war at a time of rising budget deficits, given the extent to which they are said to imperil our national wellbeing? National “solvency” or “affordability” never seem to be applied consistently across the board. Only when the issue of social welfare arises, do claims of fiscal profligacy become part of the debate.

Parenthetically, it is also worth overlaying US government fiscal deficits with movements in interest rates and inflation rates and changes to US tax regimes. These can all be seen at the US Treasury’s web site. You will see that they bear no statistically significant relationship with budget deficit levels per se over this entire period. The strongest relationship that can be established is the relationship between deficits and expenditure and hence economic growth (and employment growth).

Yet almost daily, we are bombarded with assertions bordering on the theological to the effect that budgetary profligacy, escalating health care costs and an aging population will inevitably lead to a day of “fiscal reckoning”. Read Don Peck’s story in the latest Atlantic Magazine: “How a New Jobless Era will Transform America“.

The story recounts what is undoubtedly the real intergenerational war that is being set up before our eyes. Forget about future public debt service becoming a yoke around the neck of future generations. The retired and retiring baby boomers want their high nominal fixed incomes plus purchasing power preservation (if not deflation) now and until the day they die. The youth want jobs and the prospects of a life worth living. The fiscal rectitude wing is literally strangling the baby in the crib today by denying a sensible fiscal response for the current generation’s plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow.

Viewed from that perspective, the terms of the debate have been truly twisted around. Granted, it is obviously more difficult to make the case for more government spending when legitimate distrust reasonably exists of dysfunctional financial and governmental systems. We have failed to adequately harness that distrust (and both President Obama and his Democrat allies are hugely culpable in this regard), which is naturally a distrust the deficit hawks can easily exploit today to satisfy their own agenda.

But at least the US has also been the common ground of populists and small “d” democratic reformers, and somehow, we have to find a way to speak to that effectively.

Marshall Auerback

About 

Marshall Auerback, has 29 years experience in the investment management business, serving as a global portfolio strategist for Madison Street Partners, LLC, a Denver based hedge fund. He also has also worked as an economic consultant to PIMCO, the world’s largest bond fund management group. He is a Fellow at the Economists for Peace and Security, a Research Associate at the Levy Institute, and a non-executive director of Pinetree Capital in Toronto, Ontario, Canada.

11 Comments

  1. Anonymous says:

    If its possible for a country to deficit spend its way to prosperity, why aren’t those countries with the biggest deficits the most prosperous?

  2. jzw says:

    this is another one of those misleading arguments that more Govt spending will help as it omits the most important point about Govt spending – when a govt is not constrained in its spending (having to tax before it can spend) politicians will spend money first to ensure their own re-elections and pay-off their backers while paying lip service to acting for the common good. Supporting bigger Govt is supporting a (more) corrupt Govt.

  3. Jo says:

    But, but the recovery….we have to spend – but don’t worry, we’ll be entirely responsible about it….tomorrow, just not today..please, oh please don’t turn off the candy tap…..why, they might not need so many professors.

  4. haris07 says:

    Marshall and other MMT proponents (Mosler, Wray, Bill etc.) are accurate in their theory of how modern monetary system works and that they are right on credit creating reserves, and also on deficits in and of themselves not mattering in a fiat currency system. What they all fail to see if that their idea of deficit spending our way out of trouble will NOT work because the deficits (or as they argue just printing $ w/o even issuing treasuries) will be channeled into mostly unproductive uses. So, govt will run up deficits, money will be printed and a substantial majority of this will be used to create asset bubbles and in other unproductive uses. This will eventually lead to inflation.

    And they also ignore the social consequences of something like this – what about the millions who saved money and spend prudently and stayed within their earnings capacity? The dis-savers will be rewarded and upon seeing this happen, society will gravitate towards dis-saving, over spending, and unproductive asset bubble building, all with the secure knowledge that govt will just print money and bail them all out if trouble hits.

    The theory works IF there was a good, efficient way to channel deficit spending to productive uses alone. This doesn’t work in the practical world, and all that will happen is another asset bubble and eventually high inflation.

    Deficit spending and money printing w/o true productive economic growth is no panacea! Indeed, it will be destructive to society.

    • Okay, so we don’t do any more government spending. We can cut taxes, if
      the government spending bothers you. That’s a political choice. In fact, a
      number of us have suggested a payroll tax holiday for precisely this
      reason. But if you (and others who have commented) suggest that we reduce the
      size of government via spending cuts or tax increases, then consider what
      happens. We get yet more economic contraction, larger deficits, larger
      corresponding public debt, which is precisely the opposite of what most people
      want. As I said in the piece, you cannot reduce government deficits via
      legislative fiat (unless you also want to engage in some form of mass
      extermination to bring the supply of people in line with current aggregate demand, not
      a particularly desirable outcome).

      The proposals don’t “punish” the millions who saved money and stayed within
      their earnings capacity. Government debt issuance increases
      non-government savings, dollar for dollar. That’s an accounting identity, not high
      Keynesian theory. If you’re suggesting that the spending ultimately is
      inflationary and therefore punishes savers, well, my argument (as well as those
      of Warren Mosler, Randy Wray, Bill Mitchell, and others) is that you spend to
      the degree required to get the economy back to full output, but reduce to
      mitigate inflationary outcomes. People miss this crucial point.

      So actually, I think the proposals I’ve made work in the real world as
      well. One must start with the premise that for every dollar of spending,
      there must be a corresponding revenue of an equivalent amount that must be
      accounted for. Once that is understood, there is but a short step to get to
      the basic national accounting identity from which you could then sort out the
      net financial flows, indicating that private sector saving is nothing more
      than the pecuniary accounting of the public sector surplus (if you abstract
      from foreign net borrowing/lending). The challenge is how to get
      individuals to think outside of their microeconomic box. Judging from the comments I
      have read, most people still don’t get that part.

      In a message dated 2/18/2010 08:46:11 Mountain Standard Time,
      writes:

      ======

      • haris07 says:

        To clarify, I am no deficit hawk or Austrain economics advocate (I think Austrian economics followed to its logical conclusion will be far worse than we are now!). I also don’t argue with govt spending “per se”. I also buy into the accounting identity and indeed pretty much most of what MMT says – took me a while to digest it all, but I am now a convert!

        What I don’t see happening in the real world is the non-government saving you mention above being used productively. You advocate deficits up to the point of full economic output, and I agree, IF the spending can be channeled effectively to economic output and not towards malinvestment and asset bubbles!

        In a nutshell, I believe I am among the few who actually does understand MMT, and believes it (I don’t trash the theory at all, I think its a wonderful theory of how real world monetary systems work!). I just don’t see it being practically deployed in a real world where all it will do (or mostly do) is be usurped by special interests, asset bubbles and other unproductive uses.

        My take, FWIW, is to deploy modest amounts of very directly targeted deficit spending (your payroll tax idea fits that bill), couple it wil some forced deleveraging and debt reduction (let the private sector take “some” pain, this isn’t just free money being doled out to folks who lived beyond their means i.e. throw a mix of Austrian economics into the mix). So, I agree with your thesis but only in part, I just don’t see that it will effectively be the only solution to this problem.

        If this is followed as the only solution, then the end result I foresee is more asset bubbles, high inflation and a society that has more malinvestments than productive growth. I just don’t trust that a big government will be able to channel deficits effectively and that somewhere in that bureaucratic chain, special interests won’t usurp it for unproductive uses.

        • My point is that if you have massive tax cuts, don’t you deal with the
          issue of unproductive government spending? It’s us spending (or saving) the
          money, not the government.

          You probably don’t get the same kind of spending multiple, which probably
          means substantially lower tax rates, but I think this addresses your primary
          objection.

          In a message dated 2/18/2010 10:37:54 Mountain Standard Time,
          writes:

          ======

          haris07 wrote, in response to Marshall Auerback:

          To clarify, I am no deficit hawk or Austrain economics advocate (I think
          Austrian economics followed to its logical conclusion will be far worse than
          we are now!). I also don’t argue with govt spending “per se”. I also buy
          into the accounting identity and indeed pretty much most of what MMT says –
          took me a while to digest it all, but I am now a convert!

          What I don’t see happening in the real world is the non-government saving
          you mention above being used productively. You advocate deficits up to the
          point of full economic output, and I agree, IF the spending can be
          channeled effectively to economic output and not towards malinvestment and asset
          bubbles!

          In a nutshell, I believe I am among the few who actually does understand
          MMT, and believes it (I don’t trash the theory at all, I think its a
          wonderful theory of how real world monetary systems work!). I just don’t see it
          being practically deployed in a real world where all it will do (or mostly
          do) is be usurped by special interests, asset bubbles and other unproductive
          uses.

          My take, FWIW, is to deploy modest amounts of very directly targeted
          deficit spending (your payroll tax idea fits that bill), couple it wil some
          forced deleveraging and debt reduction (let the private sector take “some”
          pain, this isn’t just free money being doled out to folks who lived beyond
          their means i.e. throw a mix of Austrian economics into the mix). So, I agree
          with your thesis but only in part, I just don’t see that it will effectively
          be the only solution to this problem.

          If this is followed as the only solution, then the end result I foresee is
          more asset bubbles, high inflation and a society that has more
          malinvestments than productive growth. I just don’t trust that a big government will
          be able to channel deficits effectively and that somewhere in that
          bureaucratic chain, special interests won’t usurp it for unproductive uses.

          IP address: 64.111.69.162
          Link to comment: http://disq.us/c9dr1

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  5. LavrentiBeria says:

    “But at least the US has also been the common ground of populists and small “d” democratic reformers, and somehow, we have to find a way to speak to that effectively.”

    One gets the distinct feeling that the “common ground of populists and small “d” democratic reformers of which you speak has been eviscerated and in a way not unlike that experienced by the left in Germany after Hitler’s ascension to power in 1933. What “populist” voices exist are those of the brownshirt Tea Parties, now themselves beached and reduced to an extension of the Republican Party. Hardly a help in any case these, with their libertarian pseudo-religion and their almost sociopathic vision of moral constraints. Sorry Marshall, but I just don’t see a “peoples’ moment” anytime soon. That, it seems to me, will require more time, another downleg and even higher unemployment.

  6. Attitude_Check says:

    Sorry, it’s too late to be counter-cyclical. That boat sailed 20 years ago when we deficit spent during the boom.

    It is now “pay me now or pay me later time” and as we all know, later us MUCH MORE EXPENSIVE